THE CONTINUITY OF BUSINESS TESTS FOR … · This means that all of the company’s activities are surveyed, but considered as a whole to determine their effect on the overall identity

THE CONTINUITY OF BUSINESS TESTS FORCARRYING FORWARD LOSSES

Winnie (Jo-Mei) MaSchool of LawBond University

INTRODUCTION

The Income Tax Assessment Act 1997 (Cth) ("the 1997 Act") was enacted inMarch 1997, being the first instalment of the simplification rewrite which willgradually replace the Income Tax Assessment Act 1936 (Cth) ("the 1936Act"). Among the proyisions redrafted were those governing a company’sability to carry forward losses. There are two tests that determine whether acompany can carry forward losses and deduct bad debts. The company musthave continuity of more than 50% of its beneficial ownership (continuity ofownership test); or, failing that, it must carry on the same business as it didbefore the majority change in beneficial ownership (continuity of businesstests).

This article examines the continuity of business tests. Its aims are:

To analyse the new law according to the interpretation of the old lawcontained in Taxation Ruling 95/31;

To evaluate the effectiveness of the simplification rewrite inovercoming the interpretational difficulties caused by the old law; and

To provide some guidance on how to approach the continuity ofbusiness tests.

141

(1998) Revenue LJ

As the interpretation of the old law is generally to apply to the new law, it isrelevant to examine TR 95/31 which was labelled the biggest tax ruling of1995 and "a win for business") On the other hand, it was also criticised as"an incorrect ruling discussing a flawed piece of legislation" at the taxpayers’expense.2 It is also relevant to review judicial consideration of the old law,which has been inadequate in its pronouncements on the continuity ofbusiness tests. The caution against major tax policy changes in the rewrite isreflected in the new Subdivision 165-E (of the 1997 Act), which has notresolved all the problems arising under the old s 80E (of the 1936 Act).

The new subdivision 165-E (the redrafted s 80E of the 1936 Act) enables acompany to utilise its tax losses and bad debts after failing the continuity ofownership tests in subdivision 165-D (the redrafted s 80A of the 1936 Act).3

In order to satisfy the subdivision 165-E continuity of business tests (whichare stipulated in s 165-210), a company must carry on the same business,conduct no additional businesses and enter into no new transactions after achange in its ownership and/or control.4

New law v old law

The 1936 Act contained separate but virtually identical continuity of businessand continuity of ownership tests. These are set out in Table 1 below.

For the purposes of simplicity and certainty, the 1997 Act has restructuredand consolidated the old provisions in relation to tax losses. Consequently,uniform tests of continuity of ownership (subdivision 165-D) and continuityof business (subdivision 165-E) now govern:5

o

deductions of current and prior year losses (s 165-10, s 36-25);intra-group transfers of income and net capital losses (subdivision 170-A).

Abbey P, "A win for business? The continuity of business test: TR 95/31"(1995) 46 Weekly Tax Bulletin at 937.Allerdice R, "Review of current developments in tax losses" (May 1996,Queensland State Convention) Taxation Institute of Australia 9 at 15.1997 Act, ss 165-10 and 165-13.Bevan C, "Love’s labour’s lost" (1997) 32 Taxation in Australia 91 at 93.Bevan C, ibid at 96; Longes M, "Current issues in the utilisation of losses"(1996-97) 1 Taxation Institute of Australia Convention Papers 271 at 275.

142

W Ma The Continuity of Business Tests

Table 1Continuity of Continuity of Utilisation of a company’s tax lossesOwnership test Business tests 80A s 80E Prior year losses

carry forward income losses: ss 79E,79F, 80, 80 AAA, 80AAcarry forward net capital losses:s 160ZC(5) (see TD 92/175)

. intra-group transfer of income losses:s 80G(6)(d)(ii), (e)(ii)

s 50D(2) s 50D(4)(6)(8) current year losses - calculation ofeligible notional loss

s 50H s 160ZP(9A) intra-group transfer of net capitallosses

s 63A s 63C deduction of bad debts

Table 21997 Act 1936 Act

s 165-210(1) s 80E(1)(b) Same Business Test (SBT) - whether thecompany carries on the same business throughoutthe same business test period as it carried onimmediately before the test time.

s 165-210(2)(a) s 80E(1)(c) New Business Test (NBT) - whether thecompany derives assessable income at any timeduring the same business test period from abusiness of a kind that it did not carry on beforethe test time.

s 165-210(2)(b) s 80E(1)(c) New Transaction Test (NTT) - whether thecompany derives assessable income at any timeduring the same business test period from atransaction of a kind that it had not entered intoin the course of its business operations before thetest time.

s 165-210(3) s 80E(2) Anti-avoidance Test - whether the companycommences a business or initiates a transactionprior to the test time in order to satisfy the abovethree tests.6

s 165-210(4) No Expenditure Test - whether the company incursequivalent expenditure during the same business test period

from carrying on new businesses or entering intonew transactions before the test time.

Williamson C and Bernhardt S, "S 80E: does ’same business’ mean ’identicalbusiness’? - A critical analysis of TR 94/D42" (1995) CCH Journal ofAustralian Taxation at 2; Boccabella D, "Continuity of business tests under theIncome Tax Assessment Act: policy and technical issues" 8th AnnualAustralasian Tax Teachers Association Conference Paper, 18-20 January 1996at 6 ("ATI’A Conference Paper").

143

(1998) Revenue LJ

-.

LEGISLATIVE FRAMEWORK OF SUBDIVISION 165-E7

Section 165-210 has five limbs or subsidiary tests. These are set out in Table2 above.

. ¯

Most of the italicised phrases in Table 2 give rise to interpretational issues.These have been examined in TR 95/31. This ruling about s 80E of the 1936Act is taken to be a ruling about s 165-210 of the 1997 Act, so far as the twoprovisions express, the same ideas.8 For instance, ."same business test" is thegeneri( name for s 165-210, even though it is itself one of the various testscontained in s 165-210 which are based on the continuity of business.

Compare and contrast the three tests

a) Common elements

The test time (equivalent to "the change" in s 80E) is the time whenthe continuity period ends. In other words, it represents the point intime when the change in the beneficial ownership of a company resultsin failing the continuity of ownership test.

The same business test period is tl~e period during which thecontinuity Of business tests must be satisfied.9 I!s meaning is-equivalent to that of "the year of income" in s 80E.

b) Differences

Section 165-210(1) refers to "throughout the same business test period",1°

whereas s 165-210(2) refers to "at any time during the same business testperiod". 11

_

S~e appendix for the full text of s 80E of the 1936 Act and s 165-210 of the1997 Act.

8 1997 Act s 1-3. However, the explicit preservation of tax rulings alone createsu.ncertainty as to whether existing case law is~still relevant to the 1997 Act. It isarguably undesirable that the ATO is able to fill such "interpretation vacuum"with_its rulings: Lehmann G, "Old dog, new tricks" (1997) 31(10) Taxation inAustratia 516 at 518.

9 Longes M, above n 5 at 275. See also 1997 Act, s 995-1.10 This was formerly expressed as "at all times during the year of income" in

s 80E(1)(b).This was formerly expressed as "at any time during the year of income" ins 80E(1)(c). This difference seems to have been overlooked by the ATO.Moreover, the question-of whether "at all times" in (1)(b) requires "day-by-day"activity in the carrying on of a business was left open in Northern EngineeringP/L v FCT 80 ATC 4.025 at 4-029 per Toohey J.

144


In addition, the phrase "immediately before the test time" is not usedconsistently in the provision. By reducing the significance of the word"immediately" in TR 95/31, the Australian Taxation Office ("ATO") hasrendered the task of resolving the overlap between the multiple tests in s 165-210 more difficult.

Application of s 165-210

Prior to analysing the ATO’s approach, it is useful to identify the variouscircumstances in which s 165-210 may be infringed. These involve the re-arrangement or reorganisation of a company’s commercial activities by:12

@

®

discarding some or all of its existing activities;adding to its existing activities;retaining its existing activities on a different scale (eg, expansion orcontraction) and/or other variations.

TR 95/31: THE ATO’S INTERPRETATION

An hypothetical scenario13 has been designed to illustrate the effects ofapplying the different interpretations. This is set out in Table 3.

Table 3

CASE STUDYDecember 1989:Restaurant Pty Ltd (R Co - owned by a Japanese couple) wasincorporated and began to operate two dine-in restaurants (featuringJapanese and Italian food) in the same shopping centre. Therestaurants were quite profitable until the opening of other food shops.

March 1992:Following its losses, R Co was sold to a Chinese couple who had beenoperating a Chinese restaurant in the same area. The names of thecompany and the restaurants remained intact, however several changeswere made during the year:o Take-away service was added to the Japanese restaurant.¯ R Co and the owner of an ice-cream parlour entered into a

lease agreement, which allowed the latter to use part of thepremises of the Italian restaurant for his business.

Boccabella, above n 7 at 13; Franks S, "Company losses" (1996) Weekly TaxBulletin 24.The original example in TR 95/31 (paras 105-111) has been substantiallymodified to accommodate more issues arising from the continuity of businesstests.

145

(1998) Revenue LJ

The Commissioner’s views on the continuity of business tests will now beexamined in detail.

1 SAME BUSINESS TEST ("SBT"): S 165-210(1)

This is the primary test. There is a positive requirement that the samebusiness be maintained at two relevant points in time - namely, immediatelybefore the test time (ie, change in ownership) and the same business testperiod (ie, the recoupment period).14

a) Meaning of "bus~ness"

"Business" has been equated to "overall business" for the purposes of SBT,which represents the entirety or totality of a company’s business operations.15

This means that all of the company’s activities are surveyed, but consideredas a whole to determine their effect on the overall identity of the company’sbusiness. Thus R Co in the hypothetical scenario would be treated as carryingon only one business prior to the ownership change in March 1992, althoughthere was a "Japanese restaurant business" and an "Italian restaurantbusiness".

This amalgam of discrete businesses approach is difficult to apply.~6 This isbecause the ATO refuses to identify the overall business merely by referenceto the heart or core of the business,17 while at the same time it also refuses toidentify the business by general, industry-wide definitions.18

Three approaches are available when dealing with multiple businesses:19

Singular interpretation (widest): SBT is satisfied if the companyretains one of its previous businesses after the test time. It has beencontended that such a lenient approach be rejected,z°

14 The test time in the case study began in March 1992. It follows that the samebusiness test period is from 1 July 1991 until 30 June 1992.

15 TR 95/31 at paras 5 and 25.16 ATI’A Conference Paper, above n 9 at 17; Bryant R, "Review of current

developments involving tax losses" Tax Institute of Australia ConventionPapers 28-29 September 1995, 92 at 93.TR 95/31 at para 30 - See the criticisms in Abbey P, above n 1 at 937; Shaw JDand Poke AR, "The continuity of business test" (1995) National Accountant 56at 57; Williamson C and Bernhardt S, above n 7 at 3-5.

18 TR 95/31 at para 56(a). See also Fielder Downs (WA) P/L v FCT 79 ATC4019.

19 Williamson C and Bernhardt S, above n 7 at 14.20 Ibid at 16~

146


Plural businesses interpretation (intermediate): SBT may be satisfiedif the company retains a majority of its businesses. The ATOunsuccessfully relied on this approach in Case Y4521 arguing for theapplication of s 23(b) of the Acts Interpretation Act 1901 (Cth).22

~ Overall business approach (narrowest): This is the ATO’s currentapproach. It seems to require the retention of all previous businesses.

Table 4 below illustrates the different outcomes reached by applying two ofthese approaches.23

Table 4

Scenarios Overall Business Plural Businesses(ATO’s current approach) (ATO’s previous approach)

Discarding SBT failed. No automatic failure - depends onexisting the proportion between theactivities.24 businesses retained and

discarded.25

Adding to SBT failed if the additional SBT satisfied as the additionalexisting business has changed the business does not affect theactivities.26 identity of the existing overall identities of the separate existing

business. businesses - however possiblefailure of NB.T.27

b) Meaning of "carried on" - the "continuing business" requirement

Since the periods of comparison are the period immediately before the testtime and the same business test period, it follows that a company would failSBT if none of its businesses existed before the test time.28 Accordingly,whether the business carried on after the test time is a recommencement of an

21 Case Y45 (AAT Case 7272) 22 ATR 3395.22 Section 23(b) AIA states that "words in singular number include the plural" -

here, the word "business" in SBT includes "businesses".23 Williamson s and Bernardt C, above n 7 at 17.24 For example, if the Japanese restaurant were discarded after the test time in

March 1992.25 For example, if R CO carried on 5 businesses specialising in different

international food, then the termination of one Italian restaurant may not failSBT.The additional Chinese restaurant business since the ownership change, inMarch 1992.

27 The interaction between SBT and NBT will be addressed later in the article.28 CCH Tax Editors, 1997 Australian Master Tax Guide (1997 CCH Australia

Ltd) at 67.

147

(1998) Revenue LJ

old business, or a commencement of a new business, would depend onwhether there was a complete cessation or a mere suspension of businessbefore the test time.29 Here, several factors have been provided by the courtsand by the ATO to assist with the determination:

nature of business - eg, whether the business can be conductedpassively.3°causes of inactivity -whether these are beyond the company’scontrol.31

company’s intention - eg, whether the cessation is intended to betemporary or permanent;32 whether there is intention to resume theprevious business33 (the Commissioner has imposed additionalrequirements that the company must intend to resume the businessformerly carried on, and that the resumption must be within areasonable time).34

abandoning acts - eg, selling assets, sacking employees, paying outcreditors .35remaining activities - eg, mere preservation of assets and collection ofdebts have no element of business.36

c) Meaning of "same" - the "identity" requirement: does samebusiness = identical business?

In Avondale Motors it was held that the word "same", in the context of s 80Eimports identity and not merely similarity.37 In response to the attack on itsliteral reading of this judicial statement in the draft ruling (TR 94/D42), theATO has acknowledged Gibbs J’s38 qualification to the notion of "identical

29 TR 95/31 at paras 39 and 43.30 In Avondale Motors (Parts) P/L v FCT 71 ATC 4101, it was held that business

in dealing in motor parts and accessories is not one that can be conducted withmere passivity.

31 TR 95/31 at para 49; Case U105 87 ATC 637.32 "Temporary" is indicative of the purpose to enable the continuation of previous

business whereas "permanent" points to the purpose of abandoning the previousbusiness: AGC (Advances) Ltd v FCT 75 ATC 4057 per Mason at 4072,Barwick CJ at 4066. Query whether the ATO is correct in rejecting this HighCourt case (which deals with s 51 rather than s 80E) as authority for s 80Eregarding the "continuing business" requirement. It is to be noted that BarwickCJ and Mason J have adopted a broader view of the "same business" concept -for instance, changes in name, address and clientele are irrelevant.

33 Avondale Motors 71 ATC 4101 at 4105; Case U105 87 ATC 637.34 TR 95/31 at paras 49 and 98.35 Williamson C and Bernhardt S, above n 7 at 18.36 Avondale Motors (Parts) P/L v FCT 71 ATC 4101 at 4104; Northern

Engineering P/L v FCT 80 ATC 4025 per Brennan J at 4027, Deane J at 4028.37 Avondale Motors (Parts) P/L v FCT71 ATC 4101. Author’s emphasis.38 Ibid at 4106.

148


business" in its final ruling - namely, the business need not be "identical inevery respect".39

Consequently, a distinction is drawn between a "change in the identity of thebusiness" and a "mere change in the process by which the business is carriedon".40 Here the termination of a major activity may be an example of theformer, whereas mere expansion in scale exemplifies the latter.

How identical must the business be ?

This-is a question of degree. It demands due regard to what has changed andwhat remains the same.41 The non-exhaustive list of factors below areweighted differently, depending on the nature of a particular company’sbusiness and other circumstances of the case:42

product lines or income-producing servicesmethod of productionmarket for product/service as defined by !ocation, type of customers,etcname, goodwill and custom of the companysales - method, marketing/promotion, turnover, terms and conditionsmethod/source of financetrademarks, patents and other intellectual property rights~

increase and decrease in the number of staffdirectors and management

These factors constitute and give identity to the overall business of acompany. Accordingly, SBT is only satisfied where the business before andafter the test time can be characterised as being the same, owing to thecontinuation of a sufficient number of these factors.43 Therefore, it isimportant to keep records of these factors to demonstrate a company’scompliance with s 165-210.44

T̄R 95/31 at para 34. This means that "absolute identity" is not required: CaseN109 81 ATC 620 at 622.

4o TR 95/31 at paras 34 and 56. In other words, the issue is ."whether the structureof the business has changed, as opposed to the matters of operational detailswhich are part of the ongoing adoption of any business to commercialexigencies and changing market realities": Case Y45 22 ATR 3395 at 3400.TR 95/31 at para 55; Bernhardt S, "Continuity of business tests: a question offact and degree" (1995) Issue 40 CCH Tax Week 746.

42 TR 95/31 at paras 56(g), 57 and 58. Note that significant weight is attached tothe first four factors: paras 55 and 121.

43 Williamson C and Bernhardt S, above n 7 at 19.44 Longes M, above n 5 at 277.

149

(1998) Revenue LJ

After identifying the various changes, what is the permissible extent of thesechanges becomes the next question. The ATO allows organic growth fromadopting "new compatible operations" and reductions in "the ordinaryway".45 By contrast, a sudden or dramatic change such as acquisition bymerger may fall foul of SBT.46

While these descriptions may cause uncertainties in practice,47 a simplifiedversion is that evolution, expansion or contraction of business may not lead tochange in identity unless it is of a considerable scale and/or it is sudden. Thusit would seem that a highly specialised company in a dynamic industry islikely to fail SBT.48

Sources of identity: individual companies v group companies

Here the Commissioner has put forward two propositions:

A company’s business is identified by reference to its own activitiesand not those of other companies within the group.49However, changes in the business or identity of other companies in thegroup may result in corresponding changes for the taxpayercompany.5°

The justification for the first proposition is that all companies are separatelegal (and tax) entities which possess distinctive identities:5a Yet the secondproposition seems to be unduly harsh and somewhat contradictory. If theidentity of a business is to be ascertained solely from the taxpayer company,how can the activities of other companies change the identity of this particulartaxpayer?

d) Meaning of "immediately"

SBT is not confined to the particular activities that are carried on immediatelybefore the test time.52 This is consistent with the Commissioner’s "overallbusiness" concept, in that the constituent activities of an overall business maybe intermittent and temporarily suspended at the test time. However, theword "immediately" still imposes a temporal restriction on how far back theATO can scrutinise a company’s activities.

45 TR 95/31 at paras 10, 35 and 36.46 TR 95/31 at para 56(f).47 Bernhardt S, above n 46 at 746.48 Above n 1; Gates s and Miller H, "Same business test - carry forward of loss

deductions" (1995) Journal of Banking and Finance Law and Practice 121.49 TR 95/31 at para 53.5o TR 95/31 at paras 53 and 56(1).51 Case N109 81 ATC 620 at 624.52 q~ 95/31 at para 32.

150


Applying SBT to the scenario

R Co’s overall business before the test time in March 1992 comprises theJapanese and the Italian restaurants. These dine-in services have beenretained. R Co has also preserved its name, despite its ownership change.Thus the question is whether the additional elements have changed theidentity of R Co’s overall business:

A new take-away service in the Japanese restaurant - this is likely to beconsidered as an "organic growth" (ie, additional method of sale)which merely results in change in scale rather than change in identity(or structural change of the business).A new Chinese restaurant - this may not be regarded as an expansionof the Japanese and the Italian restaurant business, for it introduces adifferent product line and a different market. Hence the "amalgamatedbusiness" after March 1992 is not the same as the previous businessand fails SBT.53

2 NEW BUSINESS TEST ("NBT"): S 165-210(2)(a)s4

Expressed as a negative requirement, NBT prohibits a company fromobtaining income from a business in the same business test period which isdifferent in kind from the activities carried on before the test time.55

a) Meaning of "derives assessable income"

Income derivation is the operative part of NBT which represents theconnection between the company and the relevant activity after the test time.56

Hence there would be no breach of NBT if the company had not derivedincome from the relevant activity.57 The word "income" in s 80E of the 1936Act was equated to "assessable income" in TR 95/31.58

53 TR 95/31 at paras 67 and 110.54 This is originally called the "additional business" test in TR 94/D42: Shaw JD

and Poke AR, "The continuity of business test" (February 1995) NationalAccountant 56.

55 TR 95/31 at para 60 and 65; Boccabella D, "S 80E and the ATO’s continuity ofbusiness draft ruling - time to focus on key matters" (1995) 26 Weekly TaxBulletins 496.

56 TR 95/31 at para 80; ATI’A Conference Paper, above n 7 at 19.57 For example, Case K1 78 ATC 1.58 TR 95/31 at paras 15, 87 and 159.

151

(1998) Revenue LJ

Clarification of "income"

The ATO has been praised for limiting NBT’s scope in this respect, since thederivation of exempt income is not part of the mischief which CBT wasintended to prevent.59 Consequently, s 165-210(2) now explicitly refers to"assessable income". By adopting the ATO’s view, s 162-210(2) has alsorejected the interpretation which equates income with taxable income.However, the contention based on the purpose of s 165-210(2) as preventing"injection of income’’6° has its technical merits. It is arguable that whereallowable deductions exceed the assessable income from a new business, noincome injection (and thus no mischief) is taking place.61

"De minimis" exception62

This is another positive feature of TR 95/31 - namely, the derivation ofincome which is "trifling", "insignificant" or "negligible" in amount will notcause companies to fail s 165-210(2) - an approach that is in line with judicialauthorities.63

b) Mear~ng of "business of a lOnd"

"Business"

While SBT refers to the overall business both before and after the test time,NBT nevertheless focuses on the individual undertakings or enterprisescomprised in the overall business during the same business test period.64 Suchinterpretation has been criticised for its:

inconsistency - a word should be consistently interpreted in all partsof the section in which it appears;65 andimpracticality - determining what parts of the overall business shouldbe treated as separate undertakings is not free from ambiguities.66

On the other hand, those who regard the ATO’s view as "correct" and

59 TR 95/31 at para 87; ATTA Conference Paper, above n 7 at 20.60 TR 95/31 at paras 12, 23 and 63.61 ATTA Conference Paper, above n 7; Williamson C and Bernhardt S, above n 7

at 20.62 TR 95/31 at para 85.63 See, for example, J Hammond Investments Pty Ltd v FCT 77 ATC 4311

regarding rent receipt: Allerdice R, above n 2 at 14.64 TR 95/31 at para 64.65 ATTA Conference Paper, above n 7; Williamson C and Bernhardt S, above n 7

at 16.66 Bernhardt S, above n 41 at 747.

152


"sensible’’67 base their support on the context of NBT - in particular, itsinteraction with SBT. NBT would be superfluous if its content wereequivalent or, very similar to, that of SBT. However, the later discussion willreveal the ATO’s failure to eliminate the overlap between SBT and NBT.

"Of a kind"

Despite the absence of the word "same" in NBT, the ATO has imported theidentity requirement to NBT. Consequently, activities that are before andafter the test time must be regarded as being of the same kind or "within thesame field of endeavour".6s The ATO has been criticised for blurring NBTwith SBT, since both tests require that the business be "same in kind" ratherthan "similar in kind".69 However, it is suggested that this identityrequirement is not a source of overlap between the two tests, for the word"business" has different meanings,v°

The Commissioner also alludes to the point that the content of the word"kind" derives from the nature of business being carried on before the testtime.7~ It follows that the narrower the "kind" is specified, the more likely itis that the new activity will fall outside that kind.72

Due to the different meanings of "business", it is difficult to ascertain whetherthe ATO is comparing the new activity with the overall business or theparticular activity within that overall business before the test time. Theformer seems preferable, because a new activity would not be regarded as"new" if it already existed prior to the test time.

c) Meaning of "before the test time"

Unlike s 165-210(1), the word "immediately" does not qualify the phrase"before the change" in s 165-210(2). Due to the absence of such a "temporallimit", 73 one would expect that the investigation can go as far back as thecompany’s incorporation, and thereby enable the company to pass NBT, as it

67 ATI’A Conference Paper, above n 7 at 22; Abbey P, above n 1 at 937.68 TR 95/31 at para 68.69 TR 95/31 at para 100: Abbey P, above n 1 at 937.70 SBT requires that the overall businesses be of the same identity, whereas NBT

requires the particular undertakings be of the same identity - thus the two testsimpose the same identity requirement on different things. Here the overlapresults not from the identity requirement, but from the notion of "descendinghierarchy" that the overall business consists of various undertakings andtransactions.

7~ TR 95/31 at para 111.72 ATI’A Conference Paper, above n 7 at 22. For example, if the Japanese

restaurant were to be classified as a "dine-in restaurant", then a take-awayrestaurant would be of a different kind.

73 Ibid at 9.

153

(1998) Revenue LJ

would have experienced more kinds of activities.74 However, the ATO hasstated that the investigation must stop at "the point in the past where thebusiness can no longer be described as the business carried on immediatelybefore the test time.75 This means that only those activities which form partof the overall business being carried on immediately before the test time arerelevant to s 165-210(2)(a).

The Commissioner’s approach is congruent with his view that the purpose ofs 165-210(2) is to examine businesses and transactions which make up theoverall business in s 165-210(1). Nevertheless, it does not explain why"immediately" has been omitted from s 165-210(2).

Applying NBT to the scenario

As previously mentioned, the additional Chinese restaurant may also result infailure of NBT. This is because R Co has derived income from this businesswhich is different in kind from R Co’s Japanese and Italian restaurantbusiness carried on before March 1992.

3 NEW TRANSACTION TEST ("NTT"): S 165-210(2)(b)

In spite of the expression used by the legislature, NTT can also be expressedin positive terms - namely, income derived from a transaction in the samebusiness test period must be a transaction of a kind entered into before the testtime.76

Being combined with NBT in one section, the two tests share the elements of"assessable income", "of a kind" and "before the test time" mentioned above.

a) Meaning of "entered into"

This phrase has a broad meaning such as to begin, join, engage, participate; tobe concerned, involved and interested.77 It serves as a connection between atransaction and the course of a company’s business operations.

b) Meaning of "business operations"

The ATO has given this phrase the same scope as the word "business" in SBT- "everything which a company undertakes or performs in the course of itsbusiness".TM With respect, equating "business operations" (plural) with

74 Ibid at 22.75 TR 95/31 at para 84.76 Ibid.77 TR 95/31 at para 80.78 TR 95/31 at paras 14, 25 and 81.

154


"overall business" (singular) is likely to mislead, although it can beunderstood why the ATO has done so. If "business operations" wereequivalent to activities that comprise the overall business (ie, the meaning of"business" in NBT), then it would be easier to satisfy NTT, for a transactioncomprising the relevant activity is necessarily entered into in the course ofthat activity. Thus the ATO has imposed a further requirement that thisactivity also be related to the overall business, so that the transaction is withinthe course of the overall business]9

c) Meaning of "transaction"

Again the meaning is wide and covers bilateral and unilateral dealings withproperty, as well as other means (whether or not passive in character) bywhich a company derives income.8° Although it is relatively clear that NTTwill be activated when an income-earning transaction entered into during thesame business test period is outside the course of the business operationsbefore the test time,8a it is nevertheless uncertain as to whether NTT extendsto daily or regular transactions or whether it is only applicable to isolated orindependent transactions. There are two competing views.

1 Sheppard J

[The NTI’] is not intended to refer to the daily transactions involved incarrying on a business but to transactions of an isolated andindependent kind, which transactions have nevertheless arisen in thecourse of the taxpayer’s business operations82

This means that NTT is confined to transactions that are outside the ordinarycourse of "business" (ie, the meaning of business in NBT) but not outside the"business operations" (ie, the meaning of business in SBT). Here it canalready be seen why such an approach is not favoured by the Commissioner,who insists upon the "transaction-enterprise-overall business" hierarchy.83

82

83

However, it is also possible that a transaction is within the.course of the overallbusiness, even though it may not be grouped into a particular enterprise - ie, thenotion of "isolated and independent transaction".TR 95/31 at paras 78, 79, 148 and 149 - but query whether this should extend toomissions - Barron v Littman [1953] AC 96 was cited by the ATO.TR 95/31 at para 12; J Hammond Investments Pty Ltd v FCT 77 ATC 4311;Fielder Downs 79 ATC 4019.J Hammond Investments Pty Ltd, above n 63 at 4318.That is, a transaction cannot be part of the overall business (ie, the meaning of"business" in SBT) without being part of the enterprises comprising the overallbusiness (ie, the meaning of "business" in NBT). This is because the "overallbusiness" consists of various "enterprises" which consists of individual"transactions".

155

(1998) Revenue LJ

However, Sheppard J’s approach has earned academic support84 due to, interalia, its consistency with the example given in the Explanatory Memorandumto the Income Tax Assessment Bill 1965.85

2 Campbell J

[The NTI’] contemplates that the transaction not previously carried onwas one which could have been carried on in the course of thecompany’s business operations prior to the change186

This has been interpreted and adopted by TR 95/31.® NTT examines all transactions, whether they are regular or isolated

transactions.87

® However, NTT will not be failed where the transaction could havebeen entered into ordinarily and naturally in the course of businessoperations before the test time.88 This notion of potentialtransactions89 is indicative of the ATO’s relaxation of NTT since itsdraft ruling.9°

Nevertheless, NTT is still regarded as a stringent test, since a wide range oftransactions will have to be examined in order to find the requisite identity.Moreover, it has been argued that Campbell J’s approach should be rejectedfor the following reasons:

84 For example, Allerdice R, above n 2 and Boccabella D, above n 55.85 Explanatory Memorandum to Income Tax Assessment Bill 1965, extracted in

Allerdice R, above n 2 at 24. Indeed, an arrangement where a takeovercompany pays a service fee to a loss company to enable utilisation of loss is notnormally in the ordinary course of the company’s business.

86 Fielder Downs above n 63 at 4025.87 TR 95/31 at para 76.88 TR 95/31 at paras 12, 145 and 165. Conversely, an extraordinary or unnatural

transaction judged by the course of business operations will fail NTT - eg,"non-arm’s length transaction at grossly artificial prices".

89 This can be inferred from the phrase "transactions which could have beenentered into". It means that a company will not fail NqW if its new transactionis one that could have been entered into in the course of its business operationsbefore the test time. Here the comparison is between the new transaction andthe actual, as well as the potential, transactions before the test time.

9o Bryant R, above n 16 at 93; Challoner NE, "Continuing business test - s 80EIncome Tax Assessment Act" (October 1977) The Chartered Accountant inAustralia 34; Allerdice R, above n 2 at 14.But contrast the interpretation in Miller H, "Same business test - carry forwardof loss deductions" (1995) Journal of Banking and Finance Law and Practice121 at 122 - company still fails NTI’ even where transactions can becharacterised as one ordinarily involved in its business operations. If thisinterpretation were correct, then Campbell J’s formula would have created anextremely stringent NTI’, for the comparison would be between the newtransaction and only the transactions actually entered into before the test time.

156


NBT is rendered otiose by the more specific NTT, especially in itsrole as restricting the kind of activities;91 andthe scrutiny of transactions that are significant both in scale anddiversity is impractical and gives rise to unacceptable administrativecosts.92

Applying NTT to the scenario

Here the lease agreement between R Co and the owner of the ice-creamparlour is the relevant "new transaction". Such a transaction, being of anisolated and independent kind,93 can nevertheless arise in R Co’s overallbusiness as a restaurateur.94 Consequently, the lease agreement is within theambit of NTI’ on both views.

Has assessable income been derived?Depending on the terms of the lease agreement, the relevant incomemay be a deposit (key money) and/or rental. If the first rent instalmentwas not due and payable until a future date, then the deposit alonewould constitute assessable income. However it may fall within the deminimis exception, depending on its exact amount.

Does the transaction satisfy NTT?Assuming that the de minimis exception cannot be invoked then,applying the Commissioner’s approach, the lease agreement couldhave been entered ordinarily and naturally in the. course of R Co’s-business operations before March 1992.

4 ANTI-AVOIDANCE TEST: S 165-210(3)

Common elements with s 165-210(2)9s

"Business" is given the same meaning as in NBT. Again the meaning of"business oper~itions" is equivalent to that of "overall business". "Transactionof a kind" also mirrors the meaning given in NTT. In the absence of anyreported decisions on this test, these interpretations are at least internally-consistent throughout the Ruling. However, one may still wonder why the

,

J Hammond Investments Pty Ltd, above n 63 at 4318; ATI’A Conference Paper,above n 7 at 24; Boccabella D, above n 55.

92 ATI’A Conference Paper, above n 7 at 25.- 93 This is because it is not part of R Co’s dining services.94 For example, making better use of the restaurant by leasing out an unused

portion of its premises for the purpose of complementing and enhancing itsbusiness. (Italian, food plus ice-cream may be an appealing combination !)

95 TR 95/31 at para s 16, and 91-93.

157

(1998) Revenue LJ

word "business" is used by the legislature instead of "business of a kind",particularly when "transaction of a kind" is used.

Purpose element

The Commissioner’s view that the tainted purpose (ie, tax avoidance purpose)need not be the sole purpose is in conformity with the express words of s 165-210(3).96 Yet the remaining question is whether the phrase "purposes thatincluded the purpose" also suggests that the tainted purpose need not bedominant.97

5 THE NEW EXPENDITURE TEST: S 165-210(4)

Subsection (4) introduces a new disqualifier which means that a company canalso fail NBT and NTT if it incurs expenditure as a result of its newbusinesses or transactions. It increases the stringency of s 165-210 byexpanding the scope of NBT and NTT - a change that is apparentlyunfavourable to taxpayers. Yet, many seem to overlook the significance ofthis disqualifier. This may be because the unknown rationale, scope andcontent of s 165-210(4) simply make it too early and too difficult to articulateany implications.

Purpose of s 165-210(4)

The new expenditure test may have been introduced for two reasons. First, itis there to cover the loophole in the old NBT and NTT, since the trigger ofincome derivation provided an incentive to commence businesses wherereturns are deferred. Here the compromising inclusion of "assessableincome" in the new NBT and NTT has been balanced against the addition ofthis new disqualifier. Second, it is there to standardise all the continuity ofbusiness tests under the 1936 Act - the "expenditure test" is in fact an existinglimb of the same business test in relation to "eligible notional loss" for currentyear losses.98

Meaning of "expenditure"

Section 165-210(4) is almost identical to s 165-210(2), apart from itsdistinguishing (and operative) phrase "incurs expenditure". Accordingly, themeaning of this test depends upon the following open questions.

96 .TR 95/31 at para 9.97 Academic support of this view can be found in "TR 95/31:

business test" (1995) 40 Weekly Tax Bulletins 819.98 1936 Act, see s 50D(4)(b).

Continuity of

158


a)

b)

c)

When does a company "incur" expenditure for the purposes of s 165-210(4)?

What does "expenditure" mean? Under the 1936 Act, expenditure isbroadly defined to include losses and outgoings.99 However, capitalexpenditure is excluded in certain circumstances,a°° Hence a relevantquestion may be: does the common law income-capital distinctionalso apply to the meaning of expenditure?

Does the de minimis exception apply to both income and expenditure?It is arguable that the incurrence of expenditure which is negligible inamount should not cause a company to fail s 165-210(4), just as acompany will not fail s 165-210(2) by deriving a minimal amount ofincome. Consistency and fairness would suggest that the de minimisexception should be available to 165-210(4).TM

CRITIQUE OF TR 95/31

Prior to identifying the difficulties that stem from the Ruling, it is convenientto summarise some of the Ruling’s positive features:

the relaxation of SBT by removing the "absolute identity" requirementfrom TR 94/D42; 102the exclusion of exempt income from NBT and NTT;1°3

the de minimis exception to the income in NBT and NTT;1°4

the relaxation of NTT by recognising the "potential transactions"approach - TR 94/D42 treated any new transaction as capable offailing the test.1°5

99 1936 Act, see ss 51AK(5) and 136AA.~oo 1936 Act, see, eg, ss 51AGB and 89JC.1ol If the meaning of "expenditure" were intended to be wide, then s 165-210(4)

would deprive companies of their innovative but genuine attempts to improvetheir businesses. For instance, R Co in the case study would fail this test byincurring expenditure from adding the take-away service to its Japaneserestaurant and from leasing part of its Italian restaurant. Thus a de minimisexception could at least alleviate the harshness of such restraint.

lo2 "Continuity of business test: TR 95/31" (1995) Issue 38 CCH Tax Week 714 at717; Bernhardt S, above n 46 at 746; Coadys R, "TR 95/31: company losses -continuity of business test" (28-29 September 1995) Taxation Institute ofAustralia Convention Papers 99.Moschner M, "Draft ruling corrected" (1995) 30 Taxation in Australia 260 at261.

104 Allerdice R, above n 2 at 14.~o5 Bryant R, above n 16 at 93; Challoner NE, above n 90.

159

(1998) Revenue LJ

However, TR 95/31’s retrospective application~°6 has attracted popularcriticism. For instance, the potential economic impact may lead tounfairness.1°7 The problems or inadequacies of TR 95/31 will now bediscussed.

A Policy issues - purpose and function of the continuity of businesstest

From 1944 to 1965, companies that failed the continuity of ownership testforfeited their losses,a°8 The approach to the continuity of ownership test (s80A) and the later introduction of the continuity of business test (s 80E) in1965~°9 seem to send "mixed signals".11° As a result, there were twocompeting (but not necessarily incompatible)~11 views on the underlyingpolicy of s 80E.

1) Section 80E as an anti-avoidance/deduction denial section112

This suggests that s 80E is directed at the mischief of loss trafficking.113 Suchan interpretation would justify a strict approach to s 80E. In this regard,s 80A and s 80E share the same function of prohibiting loss transfers,however they attack the mischief from different perspectives. Section 80Alooks to the shareholders by piercing the corporate veil,~14 whereas s 80Efocuses purely on activities carried on by companies.115 Therefore, thecompany’s business, rather than the company itself, is the tax entity for thepurpose of s 80E. By contrast, s 80A regards company shareholders as therelevant taxpayer.

That is, before and after its date issue on 30/8/95: Para 17; Bryant R, "Reviewof current developments involving tax losses" (28-29 September 1995), TaxInstitute of Australia Convention Papers 92 at 94.

~07 Bernhardt S, above n 46 at 748.los Allerdice R, above n 2 at 10.lO9 Section 80E was inserted into the ITAA by Act No 103 of 1965. It was later

amended by Act No 51 of 1973: J Hammond Investments Pty Ltd, above n 63at 4317.

~1o AT~A Conference Paper, above n 7 at 3.III See Case Y45 22 ATR 3395: s 80E is "part of an anti-avoidance scheme

designed to prevent trafficking in loss companies" (at 3396) but it is also "asaving provision" that operates only if the company fails s 80A (at 3400).

112 For example, Avondale Motors 71 ATC 4101 at 4106; Case Y45 22 ATR 3395at 3396.

113 Bryant R, above n 16; Allerdice R, above n 2 at 14.~14 Allerdice R, ibid at 10.~5 ATFA Conference Paper, above n 7 at 8.

160


2) Section 80E as a saving/deduction restoration section116

This regards s 80E as the exception to the general rule in s 80A (which is therelevant deduction denial section in this context).117 Furthermore, s 80E canalso be viewed as an "entitlement provision", as it provides companies with agovernment subsidy in the form of a tax break on future profits.118

Since s 80E is seen to be preventing drastic consequences that wouldotherwise arise from failing s 80A, one may expect that the approach to s 80Ewould be relatively lenient. However, the contrary view has been expressedby the Administrative Appeals Tribunal119 - namely, it is appropriate to read asaving provision reasonably strictly.

In light of the limited judicial statements on s 80E’s operative policy (due tothe absence of borderline cases),12° all that can be said is that s 80E operatesonly when a company fails to pass s 80A.121 The question is whether s 80Ecan also be utilised by a company which does not satisfy the additionalcontinuity of ownership tests in s 80DA.

3) What is the nature of s 165-210?

The new continuity of business tests are expressed as alternative,safeguarding tests for loss companies which fail to satisfy the continuity ofownership test. Yet the addition of the new expenditure test suggests thats 165-210 is in substance a deduction denial section.

While the rewrite has failed to articulate the policy of the continuity ofbusiness tests, it has nevertheless clarified the following two questions whichwere unsatisfactorily addressed in TR 95/31.

a) Interaction with s 80DA

Section 80DA contains four additional continuity of ownership tests. One ofthem disallows prior year losses where the benefits from the loss deductionwould be enjoyed by those who were not the shareholders in the year in whichthe losses were incurred.122 Here the question is whether s 80E can still savea company that has failed the additional tests in s 80DA.

116 For example, Case Y45 22 ATR 3395 at 3410.117 TR 95/31 at para 12; ATTA Conference Paper, above n 7.118 Ibid.119 Case Y45 22 ATR 3395 at 3400.120 ATI’A Conference Paper, above n 7.121 Australian Tax Practice, Australian Tax Handbook (1997), Australian Tax

Practice, Sydney.122 Section 80DA(1)(d) of the 1936 Act; s 165-15(1) of the 1997 Act.

161

(1998) Revenue LJ

Both s 80A and s 80DA are subject to s 80E, while s 80A is also subject toS 80DA.123 As such, s 80A and s 80DA may be appropriately classified asthe deduction denial provisions, and s 80E may be classified as the deductionrestoration provision.

The Commissioner’s conflicting answers are, to some extent, a consequenceof the contradictory wording in s 80E. The pre-condition to the operation ofs 80E is that there must be a disqualifying change in beneficial ownership ofshares.124 The Commissioner has interpreted this to mean that s 80E onlyapplies where breach of s 80DA is attributable to ownership change (ie,failure of s 80A).125

Contrarily, the concluding sentence in s 80E(1) states that "s 80A and s 80DAdo not prevent the whole of the loss being so taken into account". This hasbeen acknowledged twice in the Ruling.126 Thus it seems that compliancewith s 80E will negate operation of s 80DA in all circumstances127 - a viewwhich is now confirmed by the 1997 Act.

Despite the rearrangement of the s 80DA tests into the new divisions 165 and175,128 it is now clear that continuity of business tests are available to losscompanies which are unable to comply with the continuity of ownership test,income injection test and tax benefit test, etc.129 Such clarification amounts toan implication that the continuity of business tests perform the function ofrestoring (as opposed to denying) loss deductions.

b) Tax avoidance purpose

A review of cases on the continuity of business tests reveals that the relevanttaxpayers in most (if not all) of the cases possessed tax avoidance motives.Moreover, s 80E(1) contains SBT, NBT and NTT, while the anti-avoidance

123 Section 80A(1) and s 80DA(1) of the 1936 Act.124 Section 80E(1)(a) of the 1936 Act.125 TR 95/31 at para 3.126 TR 95/31 at paras 4 and 8.127 AT-I’A Conference Paper, above n 7 at 5; Challoner NE, above n 90; Bryant R,

above n 16.128 Conversion Table:

129

1936 Act 1997 Acts 80DA(1)(a) s 175-10(1) income injection tests 80DA(1)(b) s 175-15(1) tax benefit tests 80DA(1)(c) omitteds 80DA(1)(d) s 165-15(1)

Sections 165-15 (2) and 17505(2) of the 1997 Act; Explanatory Memorandum tothe Income Tax Assessment Bill 1996 and associated Bills, CCH reporter, atparas 22, 234 and 22, 238.

162


s 80E(2) is expressed as an exception to s 80E(1). Two inquiries emergefrom these observations.

Are the tests in s 80E(1) purposive? In other words, does theoperation of s 80E(1) depend upon the presence of a tax avoidancepurpose?

If not, does s 80E(1) nevertheless import a purpose test into itsapplication?

With respect to the first question, a positive answer can be implied from theTreasurer’s Second Reading Speech in 1964, as well as the ExplanatoryMemorandum accompanying the 1964 Bill.13° However, this is difficult toreconcile with the structure of s 80E. Subsection (1) consists of three testswithout mentioning purpose on its face, whereas subsection (2) is a purposetest cast as an exception to subsection (1). The argument and the counter-argument may be as follows.

Section 80E(1) and (2) are to be read separately - the former is subjectto the latter, meaning that its application may be denied by the anti-avoidance subsection. Thus (2) would be redundant if (1) werepurposive.

Section 80E(1) and (2) are to be read as a whole - thus s 80E containsfour disqualifiers - SBT, NBT, NTT and tax-avoidance purpose.

The second question may be phrased as whether purpose can be a surrogatefor the identity requirement in s 80E(1). The High Court has fortified apurpose approach in Avondale Motors.a31 However, it should be noted thatthe taxpayer in that case conceded that his sole purpose was to benefit fromtax losses.

130

131

Allerdice R, above n 2 at 11.Mr Holt’s (the then Treasurer) Second Reading Speech:

The government considers that this amendment will satisfactorily meet the casesof mergers and takeovers of companies that are carried out for sound economicpurposes and with which there is not associated any transfer of profitablebusinesses from one company to another so that income which would otherwisebe taxed is derived free of tax.

Explanatory Memorandum accompanying the 1964 Bill:The paragraphs are designed to deny such a deduction in such circumstances aswhere the loss company and a company that takes it over enter into transactionswhich have, as their purpose or effect, the transfer of income from the takeovercompany to the loss company.

71 ATC 4101 at 4106: "[The purpose of s 80E is] to prevent persons fromprofiting by acquisition of control of a company for the sole purpose of claimingits accrued losses as a tax deduction."

163

(1998) Revenue LJ

Here the Commissioner’s answer is ambiguous, as exemplified by itsapplication of s 80E(1)(c). Paragraph 12 says that "transactions which areusually unmotivated by tax avoidance" will not fail NTT. Yet para~graph 63states that "the NBT and NTT do not depend for their operation on theexistence of a purpose of tax avoidance".

On balance it seems that, although the presence of a tax avoidance purpose isnot a pre-condition to applying s 80E(1), it is nevertheless a weighty factor indetermining whether s 80E(1) can be satisfied. By contrast, the anti-avoidance subsection in the new s 165-210 is expressed as a separate test inaddition to other continuity of business tests. This reinforces the view thatSBT, NBT and NTT are not purpose tests.

B Technical issues132 - overlap between s 165-210(1) and (2)

Truly a "descending hierarchy"?

There is no judicial authority on the complete application of the continuity ofbusiness tests. Most cases failed on the first requirement of SBT.

TR 95/31 will be evaluated in the context of the new s 165-210 rather thanthe old s 80E. The flaws in the ATO’s interpretation in this respect willdirectly affect s 165-210 to the extent that s 165-210 adopts the terminologyof s 80E.

Revisiting the structure of s 165-210

In the Commissioner’s opinion, the "three cumulative requirements’’133 form a"descending hierarchy": 134

1 SBT tests "the business of the company as an entirety" (ie, overallbusiness);

2 NBT tests "the undertakings/enterprises of that business";

3 NTT tests "the individual transactions/acts by which the business iscarried on".

132 Criticisms of the following issues have been already been dealt with:SBT - multiple businesses being treated as single business

o different meanings of "business" in SBT and NBT - a source of confusion?meaning of "transaction" - NTT rendered indistinguishable from NBT?

133 Fielder Downs, above n 63 at 4023.134 TR 95/31 at paras 20 and 78.

164


These can be represented by the two diagrams below. It is suggested thatalthough the triangular structure illustrates the notion of "hierarchy", thecircular structure nevertheless reflects the ATO’s approach more closely.

Overall Business

Overall Business Enterpise/Undertaking

Regular/DailyEnterprises/ TransactionUndertakings

Isolated/

Transactions/ Independent

Acts Transaction

Here, it can be seen that a company’s "overall business" is composed ofvarious "enterprises" and "transactions" - that is, "the business-enterprise-transaction hierarchy". The difficulty lies in categorising an activity into oneof these terms.

Searching for identity - the characterisation process

The circular structure above also clarifies the Commissioner’s approach to thecontinuity of business tests:

SBT - in characterising the business (ie, overall business), regard mustbe had to the enterprises comprising the business as a whole.NBT - in characterising an enterprise, regard must be had to thetransactions comprising the enterprise as a whole.NTT - in characterising a transaction, regard must be had to the scopeof the overall business.135

Descending in generality/scope ?

The tests become narrower and more focused as the list goes down - startingwith an examination of the overall picture in s 165-210(1), then descending to

-closer examination of its particular components in s 165-210(2). Animmediate conclusion would be that the satisfaction of the more specifics 165-210(2) entails the satisfaction of s 165-210(1). Yet the converse

That is, the new transaction must be within the overall business (in the course ofbusiness operations) but need not be grouped into a particular enterprise.

165

(1998) Revenue LJ

proposition does not apply. This is supported by the fact that the scope ofs 165-210(1) covers that of s 165-210(2).

However, such a conclusion is at odds with the following:

courts have suggested that satisfaction of s 165-210(1) increases thelikelihood of passing s 165-210(2);136 andthe examples in TR 95/31 demonstrate the perplexing possibilities ofpassing NBT but failing SBT, as well as passing both SBT and NTTbut failing NBT.137

While appearing absurd at first glance, these outcomes are not inexplicable.

Reconciling s 165-210(1) with s 165-210(2)

Academic criticism is directed at the ATO’s treatment of situations where anew undertaking is acquired and amalgamated with a company’s overallbusiness. Here, the Commissioner’s approach can be summarised asfollows:138

Apply SBT- if satisfied, thenApply NBT - two steps:

a)

b)

The secondillogical to

determine whether the new undertaking is "business of a kind"prior to the test time; andif yes, determine whether the "amalgamated business" (ie, thenew overall business) is the same as the overall business priorto the test time.139

step has encountered rigorous attack. First, it is circuitous andre-apply SBT once that test is satisfied.14° Second, NBT is

136 For example, Avondale Motors 71 ATC 4101 at 4104; J Hammond InvestmentsPty Ltd, above n 63 at 4316. This comment is inevitable if courts were to regards 165-210(1)(2) as imposing three cumulative requirements. Thus s, 165-210(1)must be satisfied before applying s 165-210(2). However, this comment canalso be construed as implicitly suggesting that s 165-210(2) is less stringentthan (or at least as stringent as) s 165-210(1).

137 TR 95/31 at paras 67, 113 and 143.138 TR 95/31 at paras 66 and 67.139 That is, whether the addition of the new undertaking changes the identity of the

previous overall business. Applying these two steps to the Chinese restaurant inthe case study:1) whether the Chinese restaurant business and the "Japanese plus Italian

restaurant business" are of the same kind;2) whether the "Japanese plus Italian plus Chinese restaurant business" and

"Japanese plus Italian restaurant business" are of the same kind.140 Abbey P, above n 1 at 937; Bryant R, above n 16 at 93.

166


rendered redundant and deprived of any practical application as it issubsumed into SBT.TM

The ideology that SBT and NBT "cover the field’’142 by embodying thepositive side and the negative side of the test respectively is not a compellingdefence. However, an attempt has been made to find a solution:

1 The "Circularity" criticism

Here the Commissioner’s defect may be remedied by reversing the order oftests - ie, apply NBT and then SBT. This seems to be contrary to the notionof "cumulative requirements" and the structure of s 165-210. Although it isappropriate for the legislature to prescribe requirements in a "descendinghierarchy", it is convenient and practical to apply the prescribed requirementsin the reverse order]43

2 The "Redundancy" criticism

As the overall business is comprised of undertakings and transactions, thescope of s 165-210(1) covers s 165-210(2). However, double scrutiny ofthese undertakings and transactions can be avoided by focusing on thecomparison between distinct activities and on income derivation.

a) Old activities v new activities~44

SBT compares the activities that have been retained after the test timewith the existing activities before the test time.145 NBT and NTT, onthe other hand, compare the distinctive new activities after the testtime with the original activities before the test time.146

This approach is favourable because of its simplicity and conformitywith the names "new business" and "new transaction" tests. In

141 Furthermore, in light of the ATO’s interpretations of "transaction" and"business operations", it is equally arguable that NTT is also being subsumedunder SBT.Allerdice R, "Review of current developments in tax losses" (1996) TaxInstitute of Australia 9 at 13.

143 This is also supported by the ordinary principle of statutory interpretation thatthe more specific section applies where more than one provision is potentiallyapplicable.Allerdice R, "Review of current developments in tax losses" (1996) TaxInstitute of Australia 9 at 12.

145 Looking at the hypothetical scenario, SBT seems to be satisfied as both theoriginal businesses of Japanese and Italian restaurants are retained after the testtime. Here, the test is applied without regard to the Chinese restaurant.

~46 Here, the additional Chinese restaurant is compared with the original Japaneseand Italian restaurants to see whether they are of the same kind.

167

(1998) Revenue LJ

addition, it is supported by Gibbs J’s example in Avondale Motors.147

However, the exclusion of new activities from the process ofcharacterising the new overall business after the test time isinconsistent with the characterisation process of the previous overallbusiness prior to the test time. 148

b) Income derivation

As previously mentioned, the phrase "derives assessable income" is animportant distinguishing feature of s 165-210(2). Here the scope ofs 165-210(2) is restricted to activities that have derived income,whereas s 165-210(1) examines all activities, whether or not incomehas been derived.

Although this observation does not remove the overlap betweensubsections (1) and (2), it nevertheless explains why a company maypass subsection (1) and yet fail subsection (2). For instance, a newactivity that has not derived income does not fall foul of subsection(2), but such an activity may be so significant that it changes theidentity of the overall business and therefore fails subsection (1).Again, the convenience in applying s 165-210(2) before s 165-210(1)is manifest.

CRITIQUE OF THE REWRITE: CAN S 165-210 PERFECT ANIMPERFECT S 80E?

Section 80E: problems and weaknesses

Section 80E has been reproved for being "a most imperfect section" thatgenerates numerous interpretational difficulties.149 There are several causesof its contentious administration.

a) The absence of an apparent policy:15° It is unclear as to whether s 80Esupplements s 80A in combating loss trafficking, or whether s 80E isintended as a recourse for companies that do not satisfy s 80A. The

147 71 ATC 4101 at 4104: before the test time a company carried on the businessof motor dealer; after the change, that compz _ ontinued to carry on the samebusiness, but carried on in addition a grocery business.

148 In the latter, the identity is ascertained from all activities carried on before thetest time. Thus the identity of the new overall business should also beascertained from all activities carried on after the test time.

149 Allerdice R, above n 2 at 14-15; ATI’A Conference Paper, above n 7 at 1;Boccabella D, above n 55.

150 ATI’A Conference Paper, above n 7 at 1.

168


b)

c)

d)

e)

mere statement that s 80E is an alternative to s 80A does not explainthe operative policy of s 80E.The misleading concealment of its objective operation:TM It has beenobserved that "the weapons which have ostensibly been introduced tocounter tax loss trafficking apply irrespective of whether or not losstrafficking or other elements of tax avoidance are present".152 Indeed,taxpayers should be informed that genuine commercial activities maystill fall foul of s 80E.Failure to achieve anti-tax avoidance (if this is its purpose): Genuinecommercial activities may be "unlucky to be caught in a net that wasput out to catch other types of fish".153 It is often argued that ageneral anti-avoidance section (eg, Pt IVA of the 1936 Act) would bea better mechanismf54Conflicting references to s 80DA: As discussed earlier, it is notcompletely settled as to whether s 80E is available only when s 80A isnot satisfied.Remoteness from commercial reality:155 Section 80E effectivelycondemns loss companies to carry on the very same business whichled to their losses in the first place. Further, it deters and penalisescreative but genuine attempts to improve a business.

Section 165-210: structural and substantive changes

The reworded and restructured provisions in s 165-210 do not materiallydiffer from those of s 80E.~56 However, several areas of ambiguity have beenclarified.

a) By establishing the primacy and applicability of s 165-210 throughother provisions in the 1997 Act, it is now certain that companies canrely on the continuity of business tests if they are unable to meet thetests contained in s 80A and s 80DA of the 1936 Act.

151 Allerdice R, above n 2: "It does not advance the interests of a democraticsociety for measures to be represented as being designed to stop loss traffickingwhen their operation is far beyond loss trafficking."

152 Ibid.153 Case K20 78 ATC 184 at 187: This illustrates "the inability of a so-called loss

trafficking test to bring about outcomes which resemble the outcome from anaccurate application of the section and which gives effect to the policy ofs 80E." (ATI’A Conference Paper, above 7 at 10).

154 Challoner NE, above n 90.155 Woellner, Vella, Burus and Barkoczy, 1996 Australian Taxation Law (6th edn

1996 CCH Australia Ltd) at 1076; Allerdice R, above n 2 at 14-15. See AT-I’AConference Paper, above 7 at 7 and 11 for opposing views regarding publicinterests in preserving employment, minimising disruption to creditors andmaintaining stability, etc.Slater T, "Valuable gains from your losses" (1996-97) 2 Taxation Institute ofAustralia Convention Papers 478 at 484.

169

(1998) Revenue LJ

b)

c)

d)

By arranging NBT and NTT in two subsections, the distinctivenessand the independence of these two tests are manifest.By stipulating the anti-avoidance subsection as a separate disqualifier,there is a strong indication that a tax avoidance purpose is not anelement in other continuity of business tests.By stating that "assessable income" is the trigger of NBT and NTT,s 165-210 has removed the controversy regarding the interpretation of"income" in s 80E.

In spite of the above positive features, s 165-210 is not immune fromcriticisms. It remains a highly contentious provision because of its retentionof certain contentious words, as well as its additional elements.

1 Existing controversies

Section 165-210 is named the "SBT" in which NBT and NTT are expressedas the elements or conditions of SBT. This has the potential of eliminatingthe ATO’s problematic and inflexible "business-enterprise-transaction"descending hierarchy. Unfortunately, the retention of contentious phrasessuch as "business of a kind", "transaction of a kind", "business operations"and "immediately before" means that the following problems remainunresolved:,~ the treatment of multiple businesses as one business;® the circuitous and duplicate application of SBT when applying NBT

(ie, overlap between SBT and NBT);® different meanings are given to the word "business" without sufficient

clarity;o the extent to which past activities can be taken into account; ando the debatable interpretation of "transaction" (ie, overlap between NBT

and NTT).Critics contend that the Tax Law ~mprovement Project rewrite has notachieved the real simplification of the tax law, for the style and policy of theold provisions often remain unaltered.157

2 New controversies

Section 165-210 uses "same business test period" and "test time" to replace"the year of income" and "the change" respectively. Yet the definitions ins 995-1 lack clarity. They tend to vary in accordance with their statutorycontext. On the other hand, the new expenditure test may render s 165-210even more contentious. Not only is it necessary to articulate its rationale andcontent, the desirability and justifiability of such a disqualifier is debatable.

157 Lehmann M, above n 8 at 517-518; (1997) 20 Australian Tax Weekly para 283.

170


CONCLUSION: A PROPOSED CBT?

In the absence of any judicial evaluation on TR 95/31, re-writing thecontinuity of business tests is indeed a daunting task. An attempt has beenmade to outline the steps in applying s 165-210. It is hoped that these stepscan aid in overcoming the difficulties concerning the inter-relationshipbetween the various disqualifiers. While the underlying concern is what testdoes the company fail to satisfy, in practice the failure of any test results inthe failure of s 165-210.158 I set out below guidelines as to how a CBT mightapply.

Guidelines on applying CBT

Step 1Identify all activities carried on before the test time (ie, ownershipchange):159

a) the SBT is failed upon the cessation of all activities before thetest time; and

b) the anti-avoidance test is failed upon the addition of newactivities to existing activities for tax-avoidance purposes (eg,loss trafficking).16°

Step 2Identify all activities carried on in the recoupment year.

Step 3Compare 1 and 2: is the identity of the overall business maintained?(S~3T)

a) Are there new activities in 27161 If yes, then:has assessable income been derived, or has expenditure beenincurred from these activities? or

A company does not satisfy s 165-210 if:a) it does not carry on the same business as it did before the test time, orb) it derives assessable income from a new business or transaction, orc) it incurs expenditure from a new business or transaction, ord) it commences a new business or transaction in order to satisfy the above tests.For example, the provision of dining services in two restaurants, featuringJapanese and Italian food.

~60 An example may be that Chinese dishes were added to the menu of the Japaneserestaurant before the test time in March 1992.

161 The new Chinese restaurant and the lease agreement - see previous conclusionsfrom applying’ NBT and NTI’.

171

(1998) Revenue LJ

b)

are these activities of a kind in 1 ? (If no, then there is a failureof either NBT or NTT).162

Are the activities in 1 retained? (SBT)If yes, what is the type and extent of changes to them?163 (eg, anexpansion or reduction in scope).If no, what is the type and number of the discarded activities?

162

163

It is difficult to identify what is a "transaction" and what is an "enterprise" or"undertaking". However, it is relatively clear from this approach that, whereone of more specific tests (ie, NBT and NTI’) in s 80E(1)(c) is failed, then SBTneed not be applied.The additional take-away service - see the relevant part of the previousapplication of SBT.

172


APPENDIX

Section 80E: Losses of previous years may be taken into account wherecompany carries on the same business

80E(1) [Continuity of business test] Subject to sub-section (2), where -(a) the whole or part of a loss incurred by a taxpayer, being a company, in

a year before the year of income would not, but for this section, byreason of a change that has taken place in the beneficial ownership ofshares in the company or in any other company, be taken into accountfor the purposes of section 79E, 79F, 80, 80AAA or 80AA;

(b) the first-mentioned company carried on at all times during the year ofincome the same business as it carried on immediately before thechange referred to in paragraph (a) took place; and

(c) the first-mentioned company did not, at any time during the year ofincome, derive income from a business of a kind that it did not carryon or from a transaction of a kind that it had not entered into thecourse of its business operations, before the change took place,sections 80A and 80DA do not prevent the whole of the loss being sotaken into account.

80E(2) [Attempt to circumvent subsection (1)]Sub-section (1) does not apply in respect of a loss incurred by a taxpayerbeing a company in a year before the year of income if-(a) before the change took place, the company commenced to carry on a

business that it had not previously carried on or entered into, in thecourse of its business operations, a transaction of a kind that it had notpreviously entered into; and

(b) the company commenced to carry on that business or entered into thattransaction for the purpose, or for purposes that included the purpose,of enabling the company to take into account, by virtue of sub-section(1), for the purposes of section 79E, 79F, 80, 80AAA or 80AA a lossthat the company had incurred in a year before the first-mentioned yearor might incur in the first-mentioned year.

Subdivision 165-E: The same business test

SECTION 165-210: THE TEST

(1) The company satisfies the same business test if throughout the samebusiness test period it carries on the same business as it carried onimmediately before the test time.

173

(1998) Revenue LJ

(2)

(3)

(4)

However, the company does not satisfy the same business test if, atany time during the same business test period, it derives assessableincome from:(a) a business of a kind that it did not carry on before the test time;

or(b) a transaction of a kind that it had not entered into in the course

of its business operations before the test time.

The company also does not satisfy the same business test if, before thetest time, it:(a) started to carry on a business it had not previously carried on;

or(b) in the course of its business operations, entered into a

transaction of a kind that it had not previously entered into;and did so for the purpose, or for purposes including thepurpose, of being taken to have carried throughout the samebusiness test period the same business as it carried onimmediately before the test time.

So far as the same business test is applied for the purposes ofSubdivision 165-B (which is about working out the taxable incomeand tax loss for the income year of change of ownership or control) thecompany also does not satisfy the test if, at any time during the samebusiness test period, it incurs expenditure:(a) in carrying on a business of a kind that it did not carry on

before the test time; or(b) as a result of a transaction of a kind that it had not entered into

in the course of its business operations before the test time.

174

Documents

THE CONTINUITY OF BUSINESS TESTS FOR … · This means that all of the company’s activities are surveyed, but considered as a whole to determine their effect on the overall identity